What Is a Cash-and-Carry Trade?
A cash-and-carry trade is an arbitrage strategy that capitalizes on price discrepancies between an underlying asset and its derivative (e.g., futures or options). By simultaneously holding a long position in the asset and shorting the derivative, traders lock in profits when prices converge.
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Key Takeaways
- Exploits pricing gaps between assets and derivatives.
- Combines a long spot position with a short futures/options position.
- Requires holding the asset until derivative expiration for delivery.
How Cash-and-Carry Trades Work
Step-by-Step Execution
- Identify Mispricing: Spot a price gap (e.g., crude oil spot vs. futures).
- Buy the Asset: Purchase the undervalued asset (e.g., spot crude).
- Sell the Derivative: Short the overpriced futures contract.
- Hold & Deliver: Carry the asset until contract expiry to fulfill delivery.
Profit is guaranteed if: (Asset Purchase Price + Cost of Carry) < Futures Sale Price
Example:
- Asset price: $100
- 1-month futures: $104
- Carrying costs: $2
Profit: $104 - ($100 + $2) = $2
Applications Across Markets
1. Credit Derivatives Market
- Negative Basis Trade: Exploits spread differences between CDS and bonds.
- Strategy: Buy bonds at par/discount + sell CDS with matching tenor.
2. Options Market
- Box Spreads: Synthetic loans with favorable implied interest rates.
- Example: S&P 500 box spread (1,000 & 2,000 strikes) locks in $1,000 at expiry.
FAQs
Q: Is cash-and-carry legal?
A: Yes! Arbitrage is encouraged to enhance market liquidity and efficiency.
Q: How does it differ from forex carry trades?
A: Forex carry trades exploit interest rate differentials, while cash-and-carry focuses on asset-derivative mispricing.
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Q: What’s the role of cost of carry?
A: It includes storage, financing, and insurance—critical for calculating break-even prices.
The Bottom Line
Cash-and-carry trades are a low-risk arbitrage tool for profiting from temporary price inefficiencies. By combining spot purchases with derivative sales, traders ensure locked-in gains upon contract settlement.
Pro Tip: Always factor in carrying costs to validate potential profits!